Multiplier Economics Essay Sample

 

Definition of the Multiplier Effect

  • This occurs when an initial injection into the economy causes a bigger final increase in national income.

For example, if the govt increased spending by £1 billion, there would be an initial increase in AD of £1bn. However, if this eventually caused Real GDP to increase by £2 billion, then the Mulitplier would have a value of 2

Multilplier (k)    =           Change in  Real GDP (Y)
                                     Change in Injections (J)

Example of a Multiplier Effect.

  • If the govt spent an extra £2 billion on the NHS this would cause salaries to increase by £2 billion, therefore National Income will increase by £2 billion
  • However with this extra income, workers will spend, at least part of it in other areas of the economy.
  • e.g.  if they spent 50% of the extra income there would be another £1 billion injected into the economy. e.g. shopkeepers would earn money from increased sales.
  • This extra spending would cause an increase in output, therefore firms would employ more workers and pay higher salaries.
  • Therefore these workers will also increase their spending. This will lead to another injection into the economy, causing higher Real GDP

 

The value of the Multiplier depends upon:

  • If people spend a high % of any extra income, then there will be a big multiplier effect.
  • However if any extra money is withdrawn from the circular flow the multiplier effect will be very small.

 

                        k =             1               =                         1
                                    1-mpc                                      mpw

  1. Marginal Propensity to Consume (mpc). This is a persons willingness to spend money, if a worker saved all his money there wouldn’t be an increase in GDP
  2. Marginal Propensity to Withdraw (mpw). This is when money is withdrawn from the circular flow it includes mpt + mpm + mps
  3. The Marginal Propensity to Tax             (mpt)
  4. The Marginal propensity to Import            (mpm)
  5. The Marginal Propensity to Save            (mps)

 

The multiplier will also be effected by the amount of spare capacity if the economy is close to full capacity an increase in injections will only cause inflation.

 

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